The golden age of LNG: market review

In 2011, the International Energy Agency (IEA) published a report entitled 'Are we entering a golden age of gas?'. The report tried to envisage what this golden age might look like: a world in which increased supply from geographically diverse sources brings down the price and increases the supply security of gas; in which China puts the fuel at the centre of its economic growth plans; and in which regional gas markets become better connected, allowing gaps in supply to be quickly plugged.

"If the policy and market drivers of the high-gas scenario develop as projected," said IEA executive director Nobuo Tanaka in the foreword of the report, "gas would grow to more than a quarter of global energy demand by 2035. Surely that would qualify as a golden age."

We're still a long way from 2035 - so it's far too early to denounce such predictions - but four years down the line, things seem to have gone in the other direction. Progress has been made on some of the individual criteria laid out by the IEA, however. A number of big LNG projects have been undertaken in various parts of the world: the 18mt/y Sabine Pass LNG terminal in Louisiana, the 16.5mt/y Yamal project near the Russian Arctic and the 15.6mt/y Gorgon project in Western Australia are just three projects set to come online between now and 2017. But demand was pretty much flat from 2012 to 2014, with 243 million tons of LNG delivered last year according to figures from BG Group.

There are a few reasons for this. Chinese industrial production has slowed considerably, lessening its appetite for imported gas - between January and August, the country's LNG imports fell by 3.7% to 12.8 million tons. At the same time, low prices have helped coal make an unwelcome comeback in Europe and in a number of key emerging markets. In India, gas-fired power generation has declined by half in the past three years, while coal-fired generation has increased by 25% due to new capacity coming online.

Speaking at the LNG Producer-Consumer Conference in Tokyo in September, Fatih Birol, an IEA executive director, said, "This is mainly basic economics. For example, today in East Asia, 1kWh of power generated from coal is half the cost of the same kWh generated from gas. The question for a new LNG project used to be: can it compete with Russian gas? But today, the question is: can it compete with domestic coal or Indian solar power?"

The huge projects set to come online over the next few years turn what is already a big problem into a potential crisis. According to estimates from energy analyst Wood Mackenzie, 140mt/y of capacity is currently under construction, which will give a significant boost to the current global supply level of 250mt/y. The price of LNG is already slumping, with prices in the fourth quarter coming in at just above $6/mmBtu in Asia and Europe, and US gas prices stuck below $3/mmBtu. (For the sake of comparison, Asian LNG was at $20/mmBtu in the first quarter of 2014.) When the new projects come online, these prices will only drop further.

"The LNG market is facing another oversupply, which is likely to be deeper and will persist for some years," says Noel Tomnay, head of global gas and LNG research at Wood Mackenzie. "Prices in Asia will be lower than in Europe, and at their lowest in 2017-2019, while prices in Europe will not reach a low point until 2020. The key question the industry is wrestling with is: how low will prices go?"

Flexible arrangements

At the moment, the big LNG producers are taking comfort in the fact that most of the output from these soon-to-be-realised megaprojects has already been contracted to buyers. Laurent Vivier, gas head at French energy company Total, points out that for its Gladstone, Yamal and (Australian) Ichthys projects, all output has already been sold respectively to buyers from Korea and Malaysia, Japan and Taiwan, and a 50/50 split of Asian and European buyers. He also points out that the company's price review strategy (which allows buyers and the seller to adjust pricing formulae based on market conditions) is well placed to handle the coming supply glut. Only a third of its portfolio is exposed to the price review process before 2020, another third just beyond 2020, and the final third not at all.

"The market at the moment is coping with increasing production," says Vivier. "It's still possible to contract long-term outlets, and we have already contracted for 2020 on a long-term basis more than half of our portfolio... You've got to adjust to the market conditions; you've got to add flexibility; and it is by being a portfolio player and by not optimising it from point to point that we are able to cope with the requirements that are coming from the client."

Despite the safety of long-term agreements, Vivier acknowledges that the flexibility to reroute cargo is vital to extracting as much value as possible in a low-price environment. Total is aiming to take maximum advantage of trade arbitrage opportunities between the Henry Hub, the UK National Balancing Point and the Japan Korea Marker, all of which react to different pricing signals. The company is doubling its trading portfolio from 7 to 15mt/y by the year 2020, and has contractual terms in place to allow cargoes to be rerouted quickly between Europe, Asia and, if needed, the regasification terminal.

"On the supply side, you can see that around 60% of our volumes are with flexible destination provisions, so we can control where we are going to move the cargoes," he says. "This ratio will stay at 60%, and we have maintained it for 2020 as well.

"For 2020," he continues, "half of it is already secured in long-term contracts; the other half is mostly made of regasification capacity that we control, and there is only a marginal part left for spot trading. This system of long-term contracts and regasification capacity provides a home for all our production, so we have a base case that we can optimise according to market opportunities."

New project woes

The trick is balancing the relatively short term against the long. None would deny that a glut of gas coming into the market in the next few years will suppress prices and put downward pressure on the revenues of LNG producers, but the long-term future of the fuel is still very bright - global demand is set to nearly double by 2025, according to the IEA. This goes some way to explaining why there has been no significant reduction in the number of projects going ahead with final investment decisions (FIDs) scheduled for 2015 and 2016. (Conversely, 45 oil and natural gas exploration projects have postponed making FIDs so far in 2015.)

Worryingly, though, no new LNG projects are being announced. With spot prices so low, it is difficult to agree on competitive long-term supply contracts for proposed projects. At the time of going to press, Petronet LNG, India's largest importer, is getting such cheap supply on the spot market that it is taking only 70% of supply agreed under a 25-year deal with Qatar, running the risk of having to pay a penalty for breach of contract. But given the labour and capital-intensity of building LNG facilities, there is a real risk that lack of investment could turn today's demand crisis into a crisis of supply.

Over the past few months, a number of high-profile voices have warned about losing sight of the long term. Speaking at the Bernstein Strategic Decisions Conference in London in September, Shell CEO Ben Van Beurden warned against drawing too many conclusions from the LNG spot price and spoke of realising the importance that long-term deals play in the future success of the industry.

"85-90% of our LNG is sold on longer-term contracts - 2-20 years - linked to oil prices and gas hub prices," he said. "Shell's integrated gas results are driven by production performance and lagged oil prices, and you can see the track record here. LNG buyers typically look for security of supply, and LNG producers generally need offtake contracts to finance new LNG projects. There are changes in the supply mix (for example, new Australia and US volumes), but the fundamentals of this market look as robust now as in the past."

Such sentiments were echoed by Chevron's executive vice-president of Chevron Gas and Midstream Pierre Breber, who also called on buyers to be realistic in their contract negotiations. They may have the upper hand now, but nothing lasts forever.

"Producers will need to drive down the costs of their projects, and buyers will need to keep an open mind that low prices today won't last if long-term supply does not keep up with demand," said Breber. "Getting the best outcome will require keeping a focus on innovation and strong partnership, as well as a long-term perspective that recognises that energy markets are the largest and most efficient in the world, and can move in two directions."